Union Bank of India - Poor show:: Macquarie Research,

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Union Bank of India
Poor show
Event
 Earnings significantly below our estimates: Union Bank reported 2QFY11
net profit of Rs2bn, 40% below our estimate of Rs5bn mainly on account of
higher than expected provisions.
 Raising TP by 17% to Rs315: We are raising our TP mainly on account of
higher sustainable RoE coming out of higher NIM assumptions.
Impact
 Asset quality woes: In our view, the biggest concern is the increase in the
delinquency rate to 3.7% from already high levels of 2% seen in 1QFY11. The
agri-debt relief related amount of Rs4.14bn was classified as NPLs this
quarter. Slippages from restructured assets have steadily increased from 1%
last year to 15% currently. The bank’s NPL coverage ratio has dropped down
from a high of 85%+ to 70%, now leaving no headroom to provide less in case
of slippages. Therefore, unless recoveries are high and/or slippages are low,
credit costs could eat away earnings.
 NII growth surprises mainly due to one-offs: NII of Rs15.4bn was higher
than our expectations mainly on account of interest on income tax refund.
Core NIMs are at 3.21% (up 18bps QoQ) have peaked, in our view, and going
forward, deposit re-pricing is likely to bring down margins. Union Bank’s NIMs
historically have been very volatile.
 Opex pressures visible: We have clearly articulated that the second option
of pension and the increase in gratuity limit is likely to negatively affect
earnings and that is precisely what happened in 2Q where staff expenses
increased 36% QoQ. The second option of pension was opened up in 2Q and
by the end of 3Q, banks will have clarity on their pension liabilities. In our
view, further negative surprises cannot be ruled out. The fact that Union Bank
has revised its pension liabilities from Rs12bn to Rs24bn (ie, from 12% of networth
to 24% of net-worth) in a single quarter is quite alarming, in our view.
Earnings and target price revision
 We are marginally fine tuning earnings. Despite the earnings miss in 2QFY11,
our EPS changes are minimal as we were very conservative on margins and
hence our NIM increase has offset the higher credit charges. We are
increasing our TP by 17% to Rs315 mainly on account of higher RoE driven
by higher NIMs and some cost of equity changes.

Price catalyst
 12-month price target: Rs315.00 based on a Gordon Growth methodology.
 Catalyst: Decline in NIMs and possible disappointment in loan growth
Action and recommendation
 Maintain Underperform – chance of disappointment is very high: Union
Bank historically has over guided and under-delivered on several important
parameters such as loan growth, slippages, etc. Even the current guidance of
25% loan growth, stable NIMs, etc. are a tall task. Reiterating Underperform
with revised TP of Rs315.